Although this issue has yet to hit the main stream media, I anticipate that it will hit in a big way. Due to the complexity of the financial house of
cards, the anatomy of this potential catastrophe will be hard to explain on the 6 o'clock news:
A credit default swap (CDS) is a credit derivative (owed debt) agreement between two parties. The "buyer" makes payments to the "seller" in
installments in exchange for the right to a payoff if there is a default or a down turn in respect of a third party referred to as the "reference
This system of offsetting the risks is employed when a seller or supplier loans money or materials to an institution or manufacturer. If the
institution or manufacturer defaults then the seller will call in the debt from the buyer of the CDS. It is an insurance policy of a kind but it is
not referred to as such since to call it insurance would mean that this trading would fall under legislative regulations. In effect, CDS trading is a
free for all with pension fund holders, corporations, etc, speculate in this for immense profits.
Since there are no regulations controlling this secretive trading, there are no guarantees that buyers have the income to cover losses. Lessons
learned from the Great Depression of the 1920 have taught us that trading on margin propelled the world to an economic catastrophe; debts that were
called in went unpaid when the stock market crashed. Today we have the credit crunch with banks and finance houses either hording cash or sinking with
the burden of subprime loans. All these loans and lack of liquidity in the financial world means that it is only a matter of time that CDS buyers are
called on to cover losses.
The extent of this trade, credit default swaps, effectively parallels the actual trading of shares, resources, products and financials goods. It is
comfortably believed that there is several hundred trillion dollars of these swaps in circulation and the distinct possibility of what is known as a
“death spiral”. A death spiral entails the stampede of buyers defaulting on their agreement, once reference entities fail to perform across the
board with the current economic decline. We already see this psychology entrenched within banks who are hoarding cash.
With the serious down turn in the performance in the futures market and the loss of liquidity in national economies, more and more institutions are
offsetting their risks as we speak.
Newsweek article on CDS dated September 27th
Hedge fund firms traditionally traded in the space were exchange rates and commodities fluctuated. With increased sophistication of the CDS market,
they moved into the more complex speculation on defaults by buying a new kind of instrument of insurance by spreading the risk of a debt they had no
exposure to but sought to profit from the collapse of banks and corporations through “short-selling”. This is the ‘greed’ that Prime Minister
Gordon Brown reacted to and he has set in motion of banning short-selling in the UK.
Short-selling shares could soon be permanently banned in the UK, Gordon Brown has said.
The prime minister told the BBC Radio 4's Today programme that it was wrong that "good companies" could be brought down by "speculative activities" in
the financial markets.
"Short-selling is something that has existed in the markets for years, but when groups of people are exploiting a difficult economic situation...it is
right to stop the short-selling," he said. "We'll be reviewing over the next four months and I'll think you find new rules come in for the future."
The bottom line is that we are really at the precipice and a major economic event will set off the cascade of CDS defaults leaving the world financial
markets with a several hundred trillion dollar black-hole.
(visit the link for the full news article)